Australia’s superannuation system continues to punch above its weight in global rankings despite foreign markets eclipsing the local sharemarket in 2020, new research has found.

Local super funds delivered the fifth-best annual returns of any country over the past five years – coming behind only Russia, Vietnam, Colombia and India.

Key to their success was Australia’s focus on defined contribution schemes rather than defined benefit schemes.

Produced by actuaries Willis Towers Watson’s Thinking Ahead Institute and US publication Pensions & Investments, the review of the world’s top 300 pension funds found that 16 Australian super funds made the top 300 when it came to total funds under management.

All bar one moved up the rankings in calendar 2020, with Rest Super falling two places to 110.

Aware Super made the biggest gain, rising 22 places as a result of its merger with VicSuper.

Australia’s largest fund, AustralianSuper, came in at No.22 in the rankings, while the nation’s sovereign wealth fund, the Future Fund, was the second-best local performer and ranked 25.

The rankings make Australia’s performance look artificially low, as the structure of systems in other countries inherently leads to larger pools of savings.

A disparate system

Australia’s voluntary super scheme sees retirement savings held in 198 competing funds, with the Future Fund reserved for unfunded Commonwealth superannuation liabilities.

But countries like Japan, Norway, Canada and South Korea, along with some big US states, hold national retirement savings or savings for particular industries in one mandated fund, which leads to larger pools of savings than Australia’s disparate system.

Australia overachieves when it comes to the percentage of assets in the top 300 funds, though, coming in at sixth position and accounting for 4.4 per cent of the total.

That puts it ahead of major economies like the UK and Germany, which rely more on government pension systems in retirement.

Solid growth

The growth performance of Australia’s major funds over the past five years also outshines many of its larger counterparts.

The average compound annual growth rate (CAGR) for leading Australian funds was about 12 per cent in local currency, putting it behind only Russia, Vietnam, Colombia and India, and well in front of other developed economies.

Those ahead of Australia in CAGR “have relatively underdeveloped pension systems which are growing quickly off a low base,” said David Knox, partner with superannuation consultancy Mercer.

Source: Willis Towers Watson

The design of Australia’s superannuation system is another reason why our super funds have performed well overall.

Across the world, particularly in developed countries, defined benefit schemes dominate, making up 63.4 per cent of funds across the top 300 pension schemes.

But defined contribution schemes, which account for the significant majority of funds in Australia, accounted for only 23.9 per cent of assets in the top 300.

“Defined contribution schemes shift most of the risk for pensions to members, while in defined benefit schemes employers carry the burden of specified payouts regardless of the state of the economy or markets,” Chant West director Ian Fryer said.

The downside of defined benefits

Defined benefit schemes need far higher exposure to bonds to ensure they have enough money on hand to meet guaranteed payments when necessary. Bonds come with lower risk but also deliver lower returns.

Defined contribution schemes, on the other hand, are far more exposed to company shares (equities), because their members carry the risk of market fluctuations.

Although this means retirement balances can go up and down over the short term, it delivers far higher returns and balances over time.

The report found the top 300 funds had an average equity exposure of 47.3 per cent – much lower than the average Australian balanced superannuation account (58 per cent in equity and equity-like investments).

Meanwhile, all regions had higher allocations to bonds than the typical Australian portfolio.

Australian funds managed to grow their position last year despite a disparity in the local sharemarket.

“International shares grew 13.8 per cent over calendar 2020 despite the COVID crash while Australian shares only grew 1.7 per cent,” Mr Fryer said.

However, Australian funds managed to hold or improve their positions because of their big international share exposures and their holdings of unlisted and alternative assets, which performed well.

Bigger is better

The survey also found that larger fund groupings were growing faster than their smaller counterparts.

The top 20 funds grew by an average of 8.9 per cent annually over the five years to 2020, while smaller funds grew by between 6.5 per cent and 7.9 per cent.

Globally, this is not a result of higher investment performance.

“Larger funds are often sovereign wealth funds and their government owners have been tipping in more money in recent years,” said Willis Towers Watson investment director Martin Goss.

Locally, mergers help explain why larger funds account for a growing share of the market.

“In Australia, we are seeing a lot of small super funds merge into larger funds and the largest ones are getting more than their fair share,” Mr Goss said.

“First State Super went into Aware Super, QSuper and Sunsuper have merged, and a number of smaller funds went into AustralianSuper.”

Five years ago, the top 20 funds accounted for 40 per cent of the top 300 assets, but by December this was up to 41.8 per cent.

Almost half of the strong growth rate in funds under management was earned during 2020, when funds among the top 20 grew by 14.6 per cent and among all funds surveyed by 11.5 per cent.

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